TOUCHE ROSS & CO. v. REDINGTON
Legal provision: Securities Act of 1933, the Securities and Exchange Act of 1934, or the Williams Act
Argument of Arnold I. Roth
Chief Justice Warren E. Burger: The case is submitted.
We'll hear arguments next in Touche Ross against Redington.
Mr. Roth, I think you may proceed whenever you're ready.
Mr. Arnold I. Roth: Mr. Chief Justice, and may it please the Court.
Section 17 (a) of the Securities Exchange Act of 1934 requires broker-dealers to make such reports as the SEC may require.
And Section 18 (a) provides an expressed damage remedy to purchasers and sellers of securities who relied upon misstatements in those Section 17 (a) reports.
The primary issue here is whether in light of the limited expressed damage remedy in Section 18 (a), whether Section 17 (a) itself also provides an additional implied private right of action in favor of costumers of brokerage firms who are not purchasers and sellers against accountants who audit the Section 17 (a) reports that contain the misstatements.
There are also two subsidiary issues here which the Court need reach only if it does find that Section 17 (a) creates an implied private right of action.
The first of those subsidiary questions is whether a trustee liquidating the business of a defunct brokerage firm pursuant to the Securities Investors Protection Act of 1970 is entitled to assert the Section 17 (a) rights of action that belong to costumers of the brokerage firm whose property he has been unable to return in the course of the liquidation.
The second subsidiary issue is whether costumers of the brokerage firm who have been compensated with money obtained from the Securities Investor Protection Corporation retain any Section 17 (a) rights, and if so is SIPC subrogated to those rights.
It is the position of petitioner, Touche Ross that there is no implied private right of action under Section 17 (a) in favor of brokerage firm, costumers or anyone else, and that such a right of action would be inconsistent with the statutory scheme, the evident legislative intent and the purposes of the statute.
It is also our position that even if you assume there to be such an implied right of action that neither the trustee nor SIPC may assert that action.
Now, this case and those issues arise out off the failure in May of 1973 of a brokerage firm called Weis Securities, and its subsequent liquidation under the Securities Investment Protection Act or SEPA as I will refer to it.
Weis at that time was a member the New York Stock Exchange and had approximately 35,000 costumers.
In April or May of 1973 the SEC and the New York Stock Exchange learned that officers of Weis had been falsifying the books and financial records of Weis so as to conceal a deteriorating financial condition.
The officer's scheme had commenced in early 1972 and had continued on until the spring of 1973, and upon discovery of the scheme in May of '73 upon SIPC's act application, the District Court in the southern district of New York ordered the liquidation of Weis and appointed the trustee.
The liquidation is ongoing and SIPC is said to have advanced $14 million in that liquidation for the purpose of paying off costumer claims.
Among the reports falsified by the Weis officers were the Weis financial reports for its fiscal yearend in May 26, 1972, the reports for a yearending about a year before the actual liquidation.
Reports which were filed with the SEC pursuant to Section 17 (a) of the 1934 Act and the implementing regulation Rule 17a-5.
Touche Ross, the petitioner here performed the annual audit with respect to those reports, but that audit failed to detect the misstatements in those reports.
According to the trustee in SIPC here in this case, Touche Ross failed to detect the misstatement because its audit was conducted in a negligent, reckless, careless, unskilled and grossly negligent manner.
It is also asserted that because the misstatements went undetected, the Weis officers were enable to continue until spring of '73 their scheme of concealing the ever increasing losses that were the result of the mismanagement by those officers.
SIPC and the trustee also alleged that had Touche Ross discovered the misstatements, effective remedial action could have been taken, the force liquidation avoided or its consequences reduced.
On the basis of those assertions, SIPC and the trustee commenced two separate lawsuits against Touche Ross.
Justice Harry A. Blackmun: At that point Mr. Roth did the Government appear below?
Mr. Arnold I. Roth: I'm sorry Your Honor?
Justice Harry A. Blackmun: Did the United States Government appear below in any capacity at all?
Mr. Arnold I. Roth: Your Honor, the SEC appeared in the Second Circuit, is that --
Justice Harry A. Blackmun: And they're not here however.
Mr. Arnold I. Roth: They are not here Your Honor.
Justice Harry A. Blackmun: Is there any significance in that?
Mr. Arnold I. Roth: I believe there is significance Your Honor.
Justice John Paul Stevens: Mr. Roth, I didn't understand what position did they take below, the SEC?
Mr. Arnold I. Roth: Your Honor the District Court had dismissed this action because on the ground that the Section 17 (a) claims of the trustee and SIPC failed to state a claim for relief because Section 17 (a) does not imply remedy for anybody.
It also dismissed the common law claims for accountant's malpractice and so forth that the trustee and SIPC asserted for lack of subject matter jurisdiction.
On appeal to the Second Circuit, SIPC and the trustee sought reversal and the SEC came in, in support of SIPC's position.
In addition to this action, the SIPC and the trust -- the other action that was commence by SIPC and the trustee was a state court action that was commenced about ten months before this one in the New York state courts.
Except for the few conclusory allegations in this action which the trustee and SIPC deem necessary in order to assert claims under Section 17 (a) of the '34 Act, the complaints are exactly identical same parties, same facts, same allegations, same damages everything.
Justice Potter Stewart: Costumers are not a party to either lawsuit.
No costumers are party to either lawsuit?
Mr. Arnold I. Roth: No costumers are party to either lawsuit.
The costumers have their own lawsuits going.
Justice Potter Stewart: Have they been paid by SIPC?
Mr. Arnold I. Roth: Your Honor I think most of the costumers have been paid off in the liquidation.
$14 million of the amount that was necessary to pay them back was put in by SIPC subject to its obligation -- in accordance with its obligations under the Act SEPA.
Justice Potter Stewart: So the costumers have been paid dollar for dollar, have they?
Mr. Arnold I. Roth: Your Honor I don't know that every single costumer has been paid dollar per dollar.
There are in fact, I know that there are some who have not been.
I believe that there are some costumers who had property at Weis which is over the limits of the amounts for which SIPC is obligated.
Justice Potter Stewart: I see.
Mr. Arnold I. Roth: To make -- those amounts subsequently had been raised and I think if the new amounts had been in effect in 1972 --
Justice Potter Stewart: They would've been paid.
Mr. Arnold I. Roth: -- they would have been even few that were not paid.
Your Honor to finish up the question, the costumers have suits primarily in the state court.
Of course, about six days after the Second Circuit came down with its decision saying for the first time in 45 years that Section 17 (a) does create an implied private right of action in favor of brokerage firm costumers.
They started an action in the southern district.
That action is presently being stayed pending this appeal.
Justice Potter Stewart: Well those costumers who were paid off dollar for dollar, how have they been damaged, are they?
Mr. Arnold I. Roth: Your Honor there's another lawsuit which Touche Ross is not a party to, but there is a decision in the Second Circuit saying that even costumers who have been paid off in full by the trustee still have causes of action that they can assert for the kinds of damages that are not compensated by SIPC.
That is, a loss is on the -- say the inability to get their shares back when they wanted them, certain tax consequences that flowed from having to --
Justice Thurgood Marshall: Against whom, this action is against whom?
Mr. Arnold I. Roth: I --
Justice Thurgood Marshall: This action is against whom, this last one you're talking about?
Mr. Arnold I. Roth: That action was commenced against the New York Stock Exchange and a brokerage firm that the Stock Exchange and SEC tried to have Weis merged with -- in the last days of its existence.
In the Second Circuit, there was a reversal by a divided court of the District Court's dismissal of this action.
The Second Circuit held first that there was an implied right of action under Section 17 (a) for the costumers.
It held that the trustee and SIPC who had been asserting that they could -- they had a claim under Section 17 (a) in their own right could -- did not have such a right.
However, the Second Circuit did say that the trustee, as the bailee of costumer property could assert the Section 17 (a) rights of costumers whose property the trustee had been unable to return in the liquidation.
The Second Circuit also said that SIPC having advanced money for the payment of certain costumers claims --
Justice William H. Rehnquist: Mr. Roth, was there any cross-petition on the part of Redington or SIPC from the decision of the Court of Appeals?
Mr. Arnold I. Roth: Yes sir.
Justice William H. Rehnquist: There was?
Mr. Arnold I. Roth: Both -- they both cross-petition, those cross-petition is --
Justice William J. Brennan: Because it is still pending here.
Chief Justice Warren E. Burger: Depending here.
Mr. Arnold I. Roth: As far as we know, yes.
Justice Potter Stewart: So the Court of Appeals held that the costumers had a private right of action under 17 (a)?
Mr. Arnold I. Roth: Right.
Justice Potter Stewart: And that these two respondents here had derivative causes of action only?
Mr. Arnold I. Roth: Yes sir.
Justice Potter Stewart: One as a bailee, the other as a subrogate.
Mr. Arnold I. Roth: Yes sir.
The -- Judge Mulligan in the Second Circuit filed a vigorous dissent in which he dissented from all of the findings or the holdings of the majority, except that he agreed with them that neither SIPC nor the trustee had any claims in their own right.
The crucial element in the statutory scheme here of course is the existence of Section 18 (a) which already provides an expressed damage remedy to a certain class for misstatements in Section 17 (a) reports.
Section 18 provides a remedy like many other remedies in the 1934 Act only to purchasers and sellers of securities who relied upon the misstatements.
The presence of Section 18 (a) in the statutory scheme reflects an apparent congressional intention that a damage remedy for such misstatements would only be available only to purchasers and sellers as specified in Section 18 (a) and would seem to require the conclusion that it would be improper to imply an additional and broader remedy under Section 17 (a) itself in favor of people who were not purchasers or sellers.
Justice Potter Stewart: Of course that's quite a different group of people for quite a different kind of damage isn't it?
In other words that's not -- these people here are costumers of the brokerage firm.
Mr. Arnold I. Roth: Yes sir.
Justice Potter Stewart: And their problem is that the brokerage firm through some chicanery went busted.
The other remedy to which you refer has to do with purchasers and sellers of securities whose damage results from misinformation or wrong doing on the part of the issuers of those securities which they purchase or sell, which is quite a different cause of action, quite a different group of protected people, quite a different kind of damage isn't it?
Mr. Arnold I. Roth: Well Your Honor I think what you have done is to state the conclusion in a different way than I have just stated.
Section 18 (a) does not give to the costumers a right of action, it only gives it to the purchasers and sellers.
Alright, now they have lost property in this debacle of this brokerage firm.
Justice Potter Stewart: Not because of anything they purchase or sold on the stock exchanges or elsewhere but just because their broker went busted.
Mr. Arnold I. Roth: That's right.
Now Your Honor the question that we have to decide today is whether they ought to have a right of action.
Now, and I think though that you have to start from the premise that if Congress were worried in 1934 about purchasers and sellers, and we know they were because the '34 Act is filled with purchaser and seller remedies.
And if they were also concerned at that time as my opponent say with brokerage firm costumers.
In fact I want to get to the legislative history that shows you this is not just so.
But the Second Circuit says, “Brokerage firm costumers are the favored wards of Section 17.”
Now if that so, then what you have is the situation where Congress knowing about both of these groups gives the purchasers and sellers an expressed remedy and doesn't give anything to the brokerage firm costumers.
So you start almost logically from the proposition that they gave one something they didn't give the other one something and they must have intended not to give it.
Now I think Your Honor that that does bring us to the cases that I say set forth the appropriate analysis for determining whether there ought to be or ought not be a private right of action for these costumers.
Those cases are Amtrak, Barbour and Blue Chip Stamps which deals specifically with the question of implying remedies from statutes that already have expressed remedies in them.
And of course Amtrak and Barbour hold that the congressional enactment of a limited expressed remedy for violation of a particular statutory provision is probative and compelling evidence of a legislative intent to preclude a broader implied remedy.
Now the implied remedy that you would get from 17 (a) is broader than the one in 18 (a).
It is a remedy for costumers, not for purchasers and sellers the typical group of people whom the 1934 Act was to protect.
Justice Potter Stewart: Well but those cases did they not, and maybe they didn't, involve explicitly conferred statutory remedies and the claim in each of those cases was that in addition to those explicitly conferred statutory remedies there were other implied private causes of action as sanctions against the same category of wrong doing.
Here we have quite two different categories of wrong doing, don't we?
Mr. Arnold I. Roth: Well Your Honor --
Justice Potter Stewart: One would be wrong doing on the part of the issuers of securities that are bought and sold -- purchased and sold by investors in the securities market, and the other -- and quite a different kind of wrong doing in this case which is wrong doing, alleged wrong doing on a part of a brokerage firm vis-à-vis its own costumers.
Mr. Arnold I. Roth: Your Honor, yes in a way that is so, but I think Your Honor that we should -- I should take you to show you the substitute that Congress thought it was giving costumers in place of the private remedy that was given to purchasers and sellers.
In the legislative history of the 1934 Act, that's where I would like to start, it makes no mention of a private right of action under Section 17 (a).
It talks only about the administrative enforcement by the SEC and about the SEC going in and inspecting brokers and dealers.
It does have one revealing thing to it though, Your Honor.
It does -- there is a statement in the legislative history that makes it clear that the SEC investigations were investigations so that they could go in and get evidence rapidly in any case where fluctuations in the price of a security indicate that manipulation may be in progress.
Now that's the kind of thing that purchasers and sellers are concerned about, and so the only indicia as to who was the special beneficiary of Section 17 (a) in the legislative history of the '34 is that it was purchasers and sellers and not so much the costumers.
However, then you come to 1970 when Congress enacted SEPA.
Now, that legislative history refers to certain protections for costumers or it did not refer to any implied right of action.
Those protections that it was referring to were the preventive monitoring system that was in its infancy and then was made much broader by SEPA itself.
The investigative, injunctive and criminal powers of the SEC to enforce its own rights under Section 17 (a) to enforce compliance by the brokerage industry with 17 (a), and it was talking also about state law the right to go into the state courts and use traditional state law remedies.
And in fact the House Report refers to some safeguards, however, on both the state and federal levels as well as an industry imposed legislation.
But the most significant thing is that the Senate Report explicitly stated that brokerage firm costumers in this situation, that Your Honor has referred to, have no remedy available to them under the 1933 and 1934 Acts.
The Senate Report says, “Apart from the voluntary trust funds, there is no protection presently available under existing securities laws for the investor whose broker goes bankrupt.”
And it also said, “Neither statute prevents the investor from loosing his entire investment if his broker fails.”
A recognition that there were some protection but that the costumer didn't have any -- he didn't have an implied right of action.
There was nowhere he could go sue for this thing, and here Your Honor, and this is the most -- a most significant thing in this case.
What Congress did was to enact SEPA and to create and to create SIPC with the function not only of being part of the early warning regulatory preventive monitoring system, but with the function of paying off costumers of failed brokerage firms.
Justice William J. Brennan: Whether or not there was any fraud?
Mr. Arnold I. Roth: That's exactly right Your Honor.
Justice Potter Stewart: And of course those committee reports were a little mistaken, at least taking them on their broad statements because costumers did in fact have remedies.
They have remedies under the Federal Bankruptcy Act and they undoubtedly had remedies at state law, didn't they?
Mr. Arnold I. Roth: Well Your Honor I think that if you read that -- read those statements in the context that they occurred, I think it's perfectly clear that they were talking about --
Justice Potter Stewart: The '33 and '34 Act.
Mr. Arnold I. Roth: -- they didn't have any '33 or '34 Act remedies.
Justice Potter Stewart: Right.
Mr. Arnold I. Roth: And Senator Musky says, “There still exists a serious gap in our securities laws” and he was talking about that gap.
They then enact SEPA and create SIPC for that purpose and Your Honor --
Justice John Paul Stevens: But even if your -- even if there is an applied remedy you still would needed SEPA, even if there's an implied remedy for fraud you still would've needed SEPA to take care of the non-fraud bankruptcy situation.
Mr. Arnold I. Roth: Well, Your Honor that may be.
Justice John Paul Stevens: Well, it is, isn't it?
I mean that's exactly what they're talking about in what you read, non-fraud situation.
Mr. Arnold I. Roth: But Your Honor they -- I think that there is still is -- even you take care of the non-fraud situation, you are taking care of the fraud situation.
Justice John Paul Stevens: Well --
Mr. Arnold I. Roth: In other words Your Honor -- in other words, purchasers and sellers of securities don't have any agency they can go to and get money from if they lose money having relied on misstatements.
Justice John Paul Stevens: Could you explain this -- could you explain this to me -- could you give me an example of a violation of 17 (a) by a broker that would give rise to litigation by a purchaser or seller where he could recover?
Mr. Arnold I. Roth: Yes sir, in fact Your Honor we have one in the southern district arising out of this very same case -- this very same Weis situation in which we are the defendant.
A subordinate -- a bank which made a subordinated loan to Weis was given the Weis Section 17 (a) report in order to induce him to make that loan, and he made the loan and Judge Wyatt, the same judge that dismissed this action held -- upheld a Section 18 (a) claim against Touche Ross based on that.
Justice John Paul Stevens: They treated the bank as what, a purchaser of securities?
Mr. Arnold I. Roth: Yes sir.
Justice John Paul Stevens: I see, but there's no -- there wouldn't be a claim by a common ordinary person just buying and selling stock over the exchange, wouldn't it?
That's a rather unusual --
Mr. Arnold I. Roth: Well, no Your Honor that's hard to imagine because the purchasers and sellers -- you know a costumer is a purchaser and seller, I mean we're talking about almost the same person but a purchaser and seller is dealing in stocks of General Motors, United States.
He's not going to buy or sell them in reliance on a Weis report.
Justice John Paul Stevens: That's right, that's why 18 (a) primarily deals with misstatements that relate to the issue or the security, does it?
Mr. Arnold I. Roth: No, Your Honor.
Section 18 (a) deals with a -- with misstatements in any report --
Justice John Paul Stevens: I understand that.
Mr. Arnold I. Roth: -- that is filed.
It is not called liability for purchasers and sellers or liability -- remedy for --
Justice John Paul Stevens: I find it difficult to imagine a case, if I am a costumer of Weis and I get a false report about Weis' financial situation, I go out and buy General Motor stock, the two just don't fit.
Mr. Arnold I. Roth: That's exactly right, Your Honor, and that's part of the crux of this problem Your Honor.
You see when you talk about a prospectus or a proxy statement that is something that goes primarily to the investor and is primarily designed to induce him to act or not act.
It may -- those documents do go to the SEC, but the SEC is really exercising the oversight kind of function and it is important that your actions be made on accurate statements, and there's a congressional policy for that.
On the other hand the Section 17 (a) reports particularly in 1972 were primarily for the purpose of going to the SEC and going to the regulatory agencies and were not designed for the basic purpose of inducing an investor to make a decision based thereon.
Now, it might be that one gets out into commerce somewhere and somebody does purchase or sell a security.
Chief Justice Warren E. Burger: I think you have completed your answer to the question Mr. Roth and your time has expired.
Mr. Arnold I. Roth: Thank you, Your Honor.
Argument of Philip R. Forlenza
Chief Justice Warren E. Burger: Mr. Forlenza.
Mr. Philip R. Forlenza: Mr. Chief Justice, if it please the Court.
I would like to go directly to the heart of petitioner's case and pick up on the points raised by Mr. Justice Stewart and Mr. Justice Stevens.
The fact of the matter is that there is no situation where a costumer has a claim under Section 18 (a) for anything that happened regarding violations of Section 17.
The fact of the matter is that Sections 17 and Sections 18 may well travel separate roads at intersected times but the fact of the matter is they go beyond that to attain different goals to protect different categories of investors.
Justice William H. Rehnquist: Mr. Forlenza, is there any substantial difference between the position of your client SIPC and the position of Redington, the trustee?
Mr. Philip R. Forlenza: On the merits?
Justice William H. Rehnquist: On the issues before this Court on --
Mr. Philip R. Forlenza: I believe not Mr. Justice Rehnquist.
Justice William H. Rehnquist: -- two trustees for this petitioner?
Mr. Philip R. Forlenza: No sir.
The question I think that has to be asked is --
Justice Potter Stewart: Well except you're here as subrogee --
Mr. Philip R. Forlenza: Yes sir.
Justice Potter Stewart: -- and there is that ultimate question --
Mr. Philip R. Forlenza: I meant on --
Justice Potter Stewart: -- about whether --
Mr. Philip R. Forlenza: -- that's right on the merits of no understanding.
Justice Potter Stewart: (Voice Overlap)-- and your co-counsel represents an --
Mr. Philip R. Forlenza: Correct.
Justice Potter Stewart: -- asserted bailee.
Mr. Philip R. Forlenza: Correct.
Justice Potter Stewart: And there's a question of whether or not he has standing in that capacity.
Mr. Philip R. Forlenza: Yes but we have no --
Justice Potter Stewart: So to that extent you are different cases.
Mr. Philip R. Forlenza: That's right on the merits we have no --
Justice Potter Stewart: Because basically, as I understand the Court of Appeals the judgment is that neither you, your client nor his client has a right of action on his own.
Mr. Philip R. Forlenza: That's correct.
Justice Potter Stewart: Isn't that correct?
Mr. Philip R. Forlenza: Well actually I don't think they raised it in a footnote --
Justice Potter Stewart: It's only a costumer's right of action.
Mr. Philip R. Forlenza: That's right.
I don't think the Court of Appeals made such a holding.
I think it in a footnote suggested it wasn't particularly receptive to it.
I think that's more accurate, but the fact of the matter is we are here on those capacities that's absolutely correct.
Justice Potter Stewart: Court held that's a costumer's right of action.
Mr. Philip R. Forlenza: That's correct.
Justice Potter Stewart: And further held that you and he for different reasons have standing to assert that right of action.
Mr. Philip R. Forlenza: That's correct, absolutely.
Justice Byron R. White: And was that the position of the Commission in the Court of Appeals?
Mr. Philip R. Forlenza: That's correct.
That costumers do have standing under Section 17 for the --
Justice Byron R. White: Do you know whether the Commission's brief filed in the Court of Appeals is part of the record here?
Mr. Philip R. Forlenza: I'm not sure it's part of the record, I --
Justice Byron R. White: But they haven't filed their own brief here now.
Mr. Philip R. Forlenza: No, and I must say that I take issue with Mr. Roth's contention that their absence is significant.
I think their record -- their position in the case is, as in the Second Circuit, they have not taken a different position in this Court.
We don't know the reasons for their nonparticipation at this level.
Now, if I may pick up again on the point about 18, I think the question that has to be asked to is, why should costumers be denied a right of action against accountant who violates Section 17 and Rule 17a-5, notwithstanding the egregiousness of the conduct of the broker or accountant or extent of the damage?
Now, Mr. Roth says, its two things.
Number one, congressional silence back in 1974 as to a private right of action is some kind of evidence.
And I think this Court has well --
Justice Potter Stewart: 1934 isn't it?
Mr. Philip R. Forlenza: 1934, I think this Court has said time and again that congressional silence, particularly when there is no pending or proposed legislation, is evidence of very little.
Justice William H. Rehnquist: Well you say the question is why should costumers be denied this right of action?
Certainly, that isn't the way you would ordinarily phrase the question when you're in a federal court, is it?
Mr. Philip R. Forlenza: Mr. Justice Rehnquist, my point was addressed to the arguments that Mr. Roth was making.
We contend that they have such a right under Section 17, they are the intended beneficiaries of that statute, they have been harmed by a violation of the statute under the Cort v. Ash or any other test be it Amtrak or Barber.
There's no legislative intent to the contrary and it is consistent with the legislative purpose.
Chief Justice Warren E. Burger: But you're not contending that it's an expressed cause of action?
Mr. Philip R. Forlenza: Absolutely not, so the question is, should this Court imply a private right of action.
The petitioner says it ought not to, not because of any --
Chief Justice Warren E. Burger: Here again, we've said -- we've implied it before from time to time, but we perhaps haven't always followed it that Congress knows how to state a cause of action.
Mr. Philip R. Forlenza: Mr. Justice --
Chief Justice Warren E. Burger: You have to rest on the general contours of what we said in Cort against Ash and some of the other cases.
Mr. Philip R. Forlenza: Absolutely, and the fact of the matter is that I think in Cort v. Ash, the Court recognized that there are times when Congress creates the duty, does not address the remedy other than placing in the hands of the Commission for example.
And it is the function of this Court when the Cort v. Ash fact is admit to imply remedy as it did in Section 14 (a) in Borak, and most interestingly in 10 (b).
Chief Justice Warren E. Burger: But then in the Piper case which is more recently certainly indicated that some necessity must be shown that it's necessary to do it or else there is no remedy whatever.
Mr. Philip R. Forlenza: Well, on the question of necessity, let me say this, I think that as to the necessary supplement to Commission action which is the phraseology used by this Court in several occasions, there is no question that the Commission nor the exchanges has ever intended to have the resources or ability to conduct the kinds of audits that are required to expose brokers fraud in hiding in that capital violation.
The fact of the matter is it's common knowledge, these kinds of audits take hundreds and hundreds of man hours.
Now the Commission hasn't got the ability nor the resources to conduct those.
Number two, Mr. Roth talks about the fact that all costumers in this case represented by the trustee who have claims of loses in excess of $1 million, because they were over the limit of the SIPC fund.
It is necessary to inquire a private right of action to compensate those costumers.
If I may get back to the Section 18 point, my adversary says that the reason for denying the private right of action to costumers not withstanding Section 17, the duty on the accountant set forth there and in the rule is not because of any clear legislative intent, but the maxim of expressio unius and this Court's decision in Amtrak.
But as Mr. Justice Stewart pointed out, in Amtrak and Barber, there was a statute directly on point giving to a certain party, in that case the Government and a very limited class of private parties, a remedy for the very wrong question.
Here, 18 deals with filed information which has an adverse effect on the price of the security, that is to say fraudulent statements.
Section 17 doesn't address that kind of situation when Congress made the contours of a Section 18 claim and made all the sense in the world for the same reasons as Blue Chip, to require a purchase or seller requirement as a limitation.
No such limitation makes sense in a costumer claim.
Indeed it's not a limitation on a remedy, it's a denial of a remedy to costumers.
Turning to the intended beneficiaries, Mr. Roth takes issue with the fact that Section 17 has as its intended beneficiaries the costumers and it only point to Sections 8 (b) and 15 (c) 3 of the '34 Act, which are the basis for the net capital rule to point out that Congress was indeed interested in protecting costumers against losses by reason of insolvency of brokerage houses.
Section 17 is the only mechanism for finding out about such violations.
Secondly, for 35 years, the Commission has interpreted the rule as protecting costumers in justly situations.
As recently as January of this year, the Daniels case the Court pointed out that a consistent and long standing interpretation by the Commission is entitled to great weight.
In that case, the interpretation is neither long standing nor consistent but that certainly how the case here with Rule 17a-5.
Now, as to this legislative intent in 1970 with the enactment of SEPA, if the Court will look closely at the Senate Report, it talked about operational difficulties in the 1960's, the back office problem that gave rise to the demise of most of the brokerage houses at that time.
They were not talking about situations where accountants had failed to pick up a fraud which exacerbated the situation where the brokerage house resulted in this demise, number one.
Number two, the void, unlike the Daniels case, was a lack of insurance, that is to say investor confidence had barely been shaken and implied lawsuits of long duration are hardly the kind of thing that would give investors the confidence they required at that time, SEPA was set up for that purpose.
The fact of the matter is Mr. Roth overstates the congressional intent.
There's nothing in the legislative history to suggest that SEPA -- excuse me, that Congress even addressed the question of implied rights against accountants.
Justice Potter Stewart: That is in 1970?
Mr. Philip R. Forlenza: 1970 with the enactment of SEPA.
Justice Potter Stewart: The Section 18 remedy was part of the original '34 Act, wasn't it?
Mr. Philip R. Forlenza: That's correct.
In 1934, there was a Section 18 remedy of purchase or seller requirement, there was 8 (b) in 1934 which is the grandfather of net capital rule, and there was Section 17 clearly designed to protect costumers.
The fact of the matter is, Congress simply did not deal with the question of whether should be an implied private right of action under 17.
Justice Potter Stewart: Anymore they did under Section 10?
Mr. Philip R. Forlenza: 10 (b) as this Court specifically pointed out, neither Congress nor the Commission considered the question.
Justice Potter Stewart: Right.
Mr. Philip R. Forlenza: The same is true with 14 (a) under Borak.
Justice Potter Stewart: Right.
Justice John Paul Stevens: Mr. Forlenza, on the question whether 17 (a) is directly intended to benefit costumers, your opponent argues well the real purpose of it is to help the SEC with its enforcement function.
And that the other courts said, “We filed with the SEC and they could look them over and maybe rebook a license” or something like that.
Is it your position in your private cause of action that the costumers relied directly on the filed reports or they were in effect didn't get the benefit of enforcement action that would've taken place if correct reports have been filed?
Mr. Philip R. Forlenza: It's the latter Mr. Justice Stevens, in addition, I'm not sure that in this kind of case reliance in its classic sense is really an element.
Well the fact of the matter is --
Justice John Paul Stevens: But reliance is an element of an 18 (a) cause of action.
Mr. Philip R. Forlenza: That's correct.
If there's reliance, it's reliance of the system if you will, but the fact of the matter is they've been directly harmed by a breakdown in the system caused by the conduct of the petitioner.
Justice John Paul Stevens: And the failure of the accountants to catch it and the failure of the SEC to catch it too, of course.
Mr. Philip R. Forlenza: Well, but again the point is upon whom is there duty evolved.
Justice John Paul Stevens: Pardon me?
And the failure of --
Chief Justice Warren E. Burger: Federal exchange to catch it (Voice Overlap).
Mr. Philip R. Forlenza: Yes, but the fact of the matter is, the mechanism set out by Congress initially in the Commission thereafter is that the Commission doesn't have the ability to pick up these kinds of deceptive practices.
The fact of the matter is, the 17 (a) report certification is the key to the system of picking up in that capital violation when the broker is trying to hide the fact.
There are spot checks by the exchange, there are monthly reports by the brokers to the exchange when the Commission has any indication whatsoever that there's something wrong, it'll send out a team of examiners.
But audits of a nature that are designed to illuminate this kind of fraud simply can't be done by the exchange.
Justice William H. Rehnquist: Because the exchange doesn't have the personnel?
Mr. Philip R. Forlenza: The personnel, the resources, the expertise, if you will, in terms of these kinds of detailed audits.
Justice William H. Rehnquist: How about the --
Mr. Philip R. Forlenza: They can't be --
Justice William H. Rehnquist: How about the SEC?
Mr. Philip R. Forlenza: I think the same, except for the expertise question, I mean the fact of the matter is, if I may Mr. Justice Rehnquist, they can hardly be criticized if in fact the machinery set up by Congress is such they were not intended to take on the function that the independent auditor voluntarily assumes.
He's the --
Justice William H. Rehnquist: Well I wasn't taking it as a criticism, but I was thinking if there are any number of criminal statutes in the country and many under staffed U.S. attorney's offices, and I don't suppose someone would come here making a claim that the fact that there aren't sufficient resources allocated to the U.S. attorneys gives an implied private right of action because the U.S. attorneys are understaffed.
Mr. Philip R. Forlenza: Well, but that reasoning has been applied under the '34 Act and securities laws and again I point to 10 (b) which is a criminal statute, 14 (a) which is a criminal statute.
The fact of the matter is, they -- when they don't work the issue before this Court is, it is appropriate necessary to imply a private damage remedy to the persons hurt by the violations, I think that's the issue.
Justice William H. Rehnquist: And you rely on Borak for that?
Mr. Philip R. Forlenza: Rely on Borak, Cort v. Ash I don't think this Court has said otherwise.
Justice Potter Stewart: Going back to the Safety Appliance Act.
Mr. Philip R. Forlenza: That's correct.
In Rigsby, and although there has been criticism by petitioner of this line of reasoning, this Court has time and again approved that reasoning and in Piper for example, the fact of the matter is the Court never reached the necessity question because the issue before the Court was who were the intended beneficiaries.
From the finding that the regulated parties were not the intended beneficiaries, I think everything else in Piper flowed.
Justice John Paul Stevens: Mr. Forlenza, may I ask one --
Mr. Philip R. Forlenza: Yes sir.
Justice John Paul Stevens: -- other question?
If you're wrong and there is no private cause of action against the accounting firm, and that you take consideration that the accounting firm is the key to the checking and catching these things, what remedy is there against the accounting firm other than state causes of action?
Mr. Philip R. Forlenza: Well, other than state causes as Mr. Roth addressed to, there are just criminal with full --
Justice John Paul Stevens: Well what would their crime be?
Is there a criminal remedy against them?
Mr. Philip R. Forlenza: Yes, I believe Section 32 of the '34 Act makes it a crime to violate any of the filing statutes or regulations, so that there actually there would be a criminal --
Justice John Paul Stevens: Against the accounting.
Mr. Philip R. Forlenza: Against the accounting firm, but as I've said before the Court has noted that criminal sanctions just don't work often and this is the reason for applying a private cause of action.
Justice Potter Stewart: Well, might not the trustee, as trustee have a private cause of action under state law against the accounting firm?
Mr. Philip R. Forlenza: Mr. Justice Stewart, I'm not sure of the answer and Mr. Colbeck's going to address the state law question if I may differ to him.
Justice Potter Stewart: Right.
Mr. Philip R. Forlenza: I would like to point out that there are only certain of the costumers in this lawsuit that Mr. Roth has made reference to and that has been stayed, and this Court, if it decides in favor of affirmance, I believe that case would probably be dismissed because between the two of us, we cover all the basis.
I think the suit that Mr. Roth referred to as giving a rise to an 18 claim under Section 17 is worth commenting on just for a moment.
Exchange National Bank purchased subordinated notes from Weis of such a complicated nature that the District Court found there was more of the nature of a security than a commercial loan.
The complications which are highly relevant are that they had provisions key to the net capital rule, were dictated by the SEC and it was agreed that they would be part of the company's net capital.
So of course, reliance by the plaintiff on the Section 17 certification was relevant, the most rarest of situations.
Congress could not have intended that situation to be a preclusive effect on Section 17 violations.
Thank you very much.
Argument of James B. Kobak, Jr.
Chief Justice Warren E. Burger: Very well.
Mr. James B. Kobak, Jr.: Mr. Chief Justice, and may it please the Court.
There are costumers with unsatisfied claims in the Weis liquidation.
There are a hundred such costumers and their claims total over $1 million.
It is essential that these costumers have a remedy when the scheme provided by Congress for regulating broker dealers, financial condition for the benefit of costumers does not work because of the wrong doing of a third party.
Here, the wrong doing is that of the accountants.
We allege in our complaint that the accountants were not only negligent but grossly negligent and reckless in failing to follow Rule 17 (a) and in failing to detect fraud which infected the yearend financial statements filed by Weis with the regulatory authorities.
Now, it's true as Mr. Roth points out in his brief that many, many other documents, financial documents are filed with the regulatory authorities by brokers in addition to these yearend audited statements.
But there are over 5,000 brokerage firms in United States.
The SEC which did appear below stated in its brief that it did not have the time or the manpower to conduct its own audits of more than 5% those 5,000 brokerage firms.
These other financial information that is furnished to the regulatory authorities is of no value except in so far as it is keyed to the audited statements that are filed annually by the brokerage house.
As long as the monthly and other data filed by the broker is consistent with the yearend statements, the SEC at where the stock exchanges would ordinarily have no reason to believe that anything was wrong.
Therefore, if the audited financial statements which are considered the barometer of the brokers' financial condition, if they are inaccurate the entire monitoring scheme established by Congress for the benefit of investors in their capacity as costumers cannot work, and there is the risk there will be loss to individual costumers as well as to SIPC which is precisely what occurred in the Weis situation.
Now, Mr. Roth accuses us of trying to make accountants scapegoats for every brokerage house liquidation and he suggests that if Congress have wanted there to be a private right of action against accountants, it would've created one in the Act.
Well, no one contends that accountants are the cause of every brokerage house liquidation, the facts here are very unique.
They involve, as our complaint alleges, gross negligence in failing to detect fraud, the facts of the Weis liquidation are very unique.
Justice Potter Stewart: You would have a -- you do have, do you not, a cause of action under the law of the State of New York?
Mr. James B. Kobak, Jr.: According to Touche Ross --
Justice Potter Stewart: As trustee not as what --
Mr. James B. Kobak, Jr.: -- as trustee, we have a derivative cause on behalf of Weis, as a corporate entity.
Justice Potter Stewart: Right.
Mr. James B. Kobak, Jr.: That is not a cause of action on behalf of the hundred costumers who have lost the million dollars.
Justice Potter Stewart: No, but it's on behalf on the corporation.
Mr. James B. Kobak, Jr.: That's correct.
Justice Potter Stewart: If it is a corporation or partnership whatever it was.
Mr. James B. Kobak, Jr.: We have a negligence action and perhaps a breach of contract action under state law.
However, in addition to the fact that that cause of action would not provide any protection for costumers who have protected --
Justice Potter Stewart: Whom except derivatively, if they get -- if you recover, the corporation would have more money to pay them their claims.
Mr. James B. Kobak, Jr.: Oh, but that would be money that would be paid to general creditors and not necessarily the costumers.
The other important limitation on our state court remedy is that according to the accountants, we can not rely even on a state court negligence action on the rules established by the SEC under Section 17 of the Exchange Act, because of Section 27 of the Exchange Act, which says that the jurisdiction of the federal courts over suits in equity and actions at law is exclusive of the jurisdiction of the state courts.
In other words, if our negligence case in state law is to depend, as it would have to depend in large part on violations of specific duties set forth in subparagraph G through I of Rule 17a-5 as it existed in 1973, the accountants say we could not rely on that as a breach of duty under state law and we would be left without a remedy.
Justice Potter Stewart: I thought wouldn't the effect of those provisions be that if you win this case you no longer have a state cause of action, because this would be your exclusive remedy?
Mr. James B. Kobak, Jr.: They said in the papers filed both in our state court action and with the District Court when they made their motion to dismiss, we had a cause of action based on negligence per se in the accountant's breach in failure to follow the provisions of Rule 17a-5.
Touche Ross said in its papers in both courts that that did not state a cause of action under Rule 17 because if there was any jurisdiction to enforce those provisions, it was the jurisdiction of the federal courts.
Justice William H. Rehnquist: Well, I take that you don't finally accept your opponent's word in the lawsuit as to whether a cause of action exists, do you?
Mr. James B. Kobak, Jr.: No I don't necessarily Your Honor, but I think that is an issue that may exist in state court actions.
In this case, there's no reason why that should even be an issue.
I think it's clear from the Borak case, I think it's clear from Justice Harlan's concurrence in the Bivens when he discusses the Borak case in a footnote that one of the reasons Section 27 exist is to ensure that there be remedies for the beneficiaries of Exchange Act provisions and that those remedies be uniform across the United States.
Now, state court law on accountants' liability has developed in ways that are divergent.
It's developed in ways that are tied to developments in professional malpractice actions.
Generally, those developments have nothing in particular to do with the federal policy of regulating broker dealers for the benefit of their costumers.
Mr. Roth says that he is relying primarily on three cases, the Amtrak case, the Barber case and the Blue Chip Stamps case.
In Amtrak and Barber, there was no equivalent of Section 27 of the Exchange Act.
In addition, if a cause of action have been recognized on behalf of the private plaintiff, in either of those cases, it would not only have been inconsistent with the congressional goals in legislating on behalf of a particular class of people, it would've been antagonistic to those goals.
For instance, in Amtrak you could've had a person in one part of the country saying, “Don't cut off my railroad” and filing a suit.
That might have been in his interest, but it would have been antagonistic to the interests of other railroad passengers or would be railroad passengers in other portions of the United States.
Similarly, in the Barber case where this Court recognized that a private citizen, a costumer of a brokerage house even though the beneficiary of the SEPA Act, should not have standing to invoke the remedies of SEPA, there was a clear antagonism among interest of the class.
One costumer might have wanted his brokerage house liquidated immediately, another would prefer that the SEC or the stock exchange undertake the efforts that this Court pointed out those authorities commonly undertake to see if that brokerage house could not be saved and spare any possible loss to costumers.
Similarly, in the Piper case where the necessity language was underscored three times on page 25, the question there was a different question.
The question was not whether any private right of action was consistent with congressional goals.
The question was whether it was necessary that the particular plaintiff involved there be given a right of action in order to effectuate those goals.
In that case, the plaintiff was not a member of the protected class and again there was a possible antagonism between his interest and the interest of the class as a whole.
That was pointed out by Chief Justice Burger on behalf of the Court at page 39 of the opinion.
The principles that are applicable here are those of the Borak case.
There are those of Bivens against six unknown narcotics agents, but there are also the principles that have been applied in a well established line of cases in the lower courts under Section 6 of the Securities Exchange Act.
Section 6 creates no private right of action expressly, that provision like Section 17 was designed by Congress for the protection of investors in --
Justice Byron R. White: Suppose you're right there's this so called private right of action, what are the elements that your client would have to prove?
Mr. James B. Kobak, Jr.: In our case, we would have to prove duty on behalf of Touche Ross breach of that duty and causation, the elements of any lawsuits.
We do not --
Justice Byron R. White: And causation would amount to what?
Mr. James B. Kobak, Jr.: Well, in our view, our prima facie showing of causation would require us to show that Touche Ross through its negligence or gross negligence or recklessness failed to detect fraud which had it discovered in a timely fashion, it would have had to alert regulatory authorities to the existence of it.
At that point, the regulatory authorities could've taken action to prevent or reduce the amount of damage that has been suffered in the Weis liquidation.
Justice Byron R. White: But in no event does either the regulatory agency or your clients or anybody else have specifically to rely on the accuracy of the statements that were filed.
Mr. James B. Kobak, Jr.: Well, the regulatory authorities do rely, our costumers --
Justice Byron R. White: Well you don't -- they don't rely, they just -- you wouldn't have to prove for example that they examined these statements and relied on them?
Mr. James B. Kobak, Jr.: No, that's correct, they rely on them to the --
Justice Byron R. White: So your answers is nobody has to rely on them?
Mr. James B. Kobak, Jr.: No, they don't have to rely, the regulatory authorities rely on the fact that the auditor has been there has supposedly performed the minimally acceptable steps required in the Rule 17a-5 audit and has discovered no irregularity.
Justice Byron R. White: To that extent they were there and for all anybody knows, they did go through some steps, they filed some wrong statements that's how I take it.
But your clients don't need to rely on anything.
Mr. James B. Kobak, Jr.: My clients are the costumers, we're the bailee --
Justice Byron R. White: I understand, I understand you know -- but you don't have to rely on anything with respect to these statements.
Mr. James B. Kobak, Jr.: No, in fact at the time in question, there was no congressional requirement or regulatory requirement of the SEC.
The costumers even received these statements.
Justice Byron R. White: Would a purchaser of securities have to rely on them?
Mr. James B. Kobak, Jr.: A purchaser of license securities would.
The case that Mr. Roth talks about is that of a subordinated lender, that subordinated lender claimed that he received a copy of the false financials.
Justice Byron R. White: Except that costumers are in a better shape than buyers.
Mr. James B. Kobak, Jr.: They're in better shape than buyers because Congress --
Justice Byron R. White: In so far as being able to impose any liability on the accountants?
Mr. James B. Kobak, Jr.: In those rare case when they suffer a loss because of a brokerage house failure.
The reason that they are in a better position is that Congress legislated it in the Exchange Act that they be the beneficiaries of a very extensive scheme of monitoring and regulating broker dealers.
When the accountant fails to act, that scheme cannot function.
Justice Byron R. White: But the buyer can recover from the accountant, but he's going to have to prove some reliance on the statements.
Mr. James B. Kobak, Jr.: He's going to have to prove reliance, that's correct because he's in a different category.
He's a purchaser and seller.
He's probably going to have to prove fraud.
Justice Byron R. White: I know, I know he's different but so your answer is yes, the costumer is in a better position and with respect to reliance than the buyer?
Mr. James B. Kobak, Jr.: When there has been a brokerage house failure, the costumer through the trustee, has to show that the system could not work because the accountants failed to alert the regulatory authorities to the existence of fraud and falsement financial statement.
Justice Byron R. White: But if he's both a costumer and a buyer and sues in both capacities, he has to prove reliance in one and not the other.
Mr. James B. Kobak, Jr.: Well, I don't think he can't sue in both those capacities at the same time.
As a costumer, he's buying through the broker --
Justice Byron R. White: Do you mean about the same thing, he can certainly could be a buyer, couldn't he?
Mr. James B. Kobak, Jr.: Well, you could conceivably have someone who is both the Weis costumer and a Weis shareholder.
Justice Byron R. White: Exactly.
Mr. James B. Kobak, Jr.: Yes, he'd be dealing in two different capacities.
He'd have different burdens of proof under both statutes.
Justice Potter Stewart: 17 and 18.
Justice Byron R. White: But tell me you're saying that -- what you're really saying is that there's implied cause of action that the Act provides a cause of action for you.
Now, why would Congress think that this -- I'm sure you know and can tell me why the -- why Congress would make it easier for the costumer than the buyer to recover from the accountant?
Mr. James B. Kobak, Jr.: Congress wanted these costumers -- Congress wanted innocent, the ignorant man in the street, the most naïve person imaginable to deal in the nation's capital markets.
It was a matter -- it's a matter of indifferent --
Justice Byron R. White: There are an awful lot of ignorant buyers around, aren't there?
Mr. James B. Kobak, Jr.: Well, that may be Your Honor, but I suggest those ignorant buyers are unable to sustain their causes of action because they're unable to prove reliance and fraud.
Justice Byron R. White: Why shouldn't -- I'm just asking, why shouldn't costumers have to prove them?
Mr. James B. Kobak, Jr.: Because Congress wanted the costumer to be able to rely on the regulatory authorities to do that for them and not have to make his own sophisticated analysis of a broker's financial statements.
Chief Justice Warren E. Burger: Thank you gentlemen.
The case is submitted.